Fiscal Stimu-less?

Quick—what’s the best way to perk up a slack economy? Since 2008, “vigorous and creative monetary policy!” was the popular response, and central bankers heeded the cry. The results: Rock-bottom (even negative) interest rates in the world’s largest economies. Quantitative easing in the eurozone, UK, US (now over), Sweden and Japan, where the central bank is buying virtually anything under the sun. Yet growth rates mostly lag past expansions. So now, there is a new fashionable response to the opening question: Monetary stimulus is no longer effective, and fiscal stimulus needs an at bat. Even central bankers seem to agree! In our view, however, this “new consensus” misses a few key points. Fiscal stimulus is handy during an actual recession, but it isn’t a sustainable growth-boosting tool, and overall and on average, the world economy doesn’t need it now. Investors shouldn’t fall into the trap of thinking government aid today is necessary to keep this expansion—and bull market—humming.

First, to be clear, we aren’t ideologically opposed to fiscal stimulus. Fast-acting tax rebates and new spending can jumpstart demand during a recession by putting new money into the economy when banks aren’t lending and businesses are retrenching. Consumers and businesses get a small boost, a temporary jolt to speed the recovery. The private sector eventually has to do the heavy lifting to get the new expansion going for real, but stimulus can be a nice salve in the meantime.

Likewise, a sharp pullback in spending or an onslaught of taxes in anemic times adds to economic pain. Tax hikes and spending cuts likely worsened the eurozone crisis in 2012, for example, by sucking resources out of the economy.[i] Waiting for data to confirm a recession before ramping up stimulus isn’t necessarily required either—acute problems in industries that represent a huge swath of the economy can also be valid reasons to prime the pump a bit. Australia's government is responding to declining commodity prices via aggressive fiscal stimulus, even though the country hasn’t experienced a recession in a quarter-century. While not crucial, the move is arguably a reasonable response to genuine headwinds, as natural resources play a heavy role in the Land of Oz. One could make a similar case for Russia, Brazil or Canada.

So, sure—in some countries, fiscal stimulus wouldn’t be ill-timed today. But for the world at large, we believe it’s a misguided attempt to fine-tune growth numbers to match forecasters’ faulty claims of where the economy could or should be. For starters, fiscal stimulus has little use when economies are already chugging along. It’s more powerful in a recession because any demand helps when private sector activity is in the dumps. Even if the government spends the money as idiotically as you can possibly imagine,[ii] the cash eventually enters the private sector and changes hands many times. Economists debate the size of this “multiplier effect,” but the general theory is sound. If the economy is expanding, however, adding a few more dollars has less effect.

Private sectors are also far bigger than public—if economic growth isn’t quite up to par, the more beneficial path is probably to support private production, not paper over perceived shortfalls with government spending. This is particularly true today, as there are few signs in many major developed economies (the UK, US and eurozone) that weak consumption is really the issue. Plus, a sudden jolt of spending boosts GDP, not economic fundamentals. This is fine in a recession: You just want to swiftly push cash into the economy while business gets back on its feet. But Japan shows substituting stimulus for reform is a short-term strategy. Despite launching thirteen fiscal stimulus packages since 2008, the country has lumbered through a trio of recessions and still struggles today—in Q2, government spending pushed GDP growth positive, but not by much (0.7% annualized). As we’ve written, Japan would gain far more from structural reforms to loosen up restrictive labor rules and roll back an oversized public sector (which crowds out businesses). The most recent stimulus bill could conjure up some demand, which might be needed—but it still isn’t a lasting fix.

Fiscal stimulus proponents argue the world is “stuck” in a slow-growth trap, and only a surge of new spending can break it out. But pining for allegedly missing “potential” demand is mere guessing—lacking a counterfactual, it’s impossible to say what growth would be if certain hypothetical conditions were met. Targeting allegedly “natural” growth rates is fanciful, possibly even harmful: Huge spending programs during an expansion could overheat the economy, queuing up a painful pullback—exactly the problem fiscal stimulus is meant to alleviate. And, the distortions this non-market-oriented force brings can cause problems in their own right. Governments generally aren’t great at allocating capital to its best possible use—markets are. Fiscal stimulus, if implemented on a grand scale, would mean massive government involvement in large swathes of the economy, soaking up resources and encouraging businesses to invest according to the government’s priorities, not the consumer’s. In other words: If it happened, we wouldn’t exactly call it a reason for investors to cheer.